The silver lining

There is a silver lining when banks' fortunes have clouded over because of the end to windfall gains through treasury operations during a regime of falling interest rates. This is that the drop in banks' profits may be shortlived.

In fact, Indian banks (particularly the nationalised ones) may be heading for a significant restructuring opportunity which, if handled well, can make them come of age in terms of global benchmarks.

The latest central bank figures indicate a rise in non-food credit, accompanied by a marginal fall in food credit. Clearly, economic activity is on the upswing and there is rising demand for short-term commercial credit.

In a way, this is the obverse of a cut in trading profits. With yields rising and interest rates hardening, firms are beginning to find it more attractive to go to banks for working capital rather than raise it through issuing commercial paper.

The rise in demand for bank loans need not be restricted to short-term credit. After a gap of eight years, Indian manufacturing is again investing in fresh capacity. This means a revival in demand for term loans from banks.

In services, retailing is giving a powerful new thrust to investment, which in turn is having a beneficial impact on construction. That is not all. The government is also waking up to the importance of improving and expanding the infrastructure and wishes to use the large foreign exchange reserves for this purpose.

While the dollar reserves can pay for machinery imports, the banks will have to provide the counterpart rupees. The new electricity law has greatly improved the prospects of investment in the power sector.

There is all-round commitment to pursuing and discovering workable models for public-private partnership in creating new infrastructure. All this is good news for banks.

Banks can also see before them expanded opportunities in retail lending. Indian banks account for a minuscule part of the individual consumer's need, compared to not just the developed economies but also intermediate ones like Korea.

But there is a catch. While Indian banks know how to lend to companies, they are still relative greenhorns in high- volume retail lending. For the latter to succeed, and not land the banks with more non-performing assets, they will have to change the way they do business.

Large volumes of consumer loans can be effectively serviced only with the use of software products designed for the purpose. Nationalised banks are mostly new to this but cannot remain so if they are to effectively supervise large retail loan volumes at affordable costs.

Thus, there is life after falling interest rates for banks, so long as they modernise and the economy keeps on its present growth path.